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Can UnitedHealth really fix the system?

May 6, 2013, 12:46 PM UTC
Illustration: Shout

The most powerful man in the U.S. health care industry is telling me about the challenges of parenting an unruly adolescent. At least it sure feels that way as Stephen J. Hemsley, the CEO of UnitedHealth Group (No. 17 on this year’s Fortune 500), describes his efforts to tame his company’s previously selfish and belligerent behavior. Hemsley is a former accountant with a reputation in the business as a taciturn, obsessive numbers man and not much of a people person. But when he sits down with me in a nondescript conference room in UnitedHealth’s headquarters in Minnetonka, Minn., for the first face-to-face interview he’s granted in his six years as CEO of the nation’s largest health insurer, Hemsley says hardly a word about premiums or actuarial data. Rather, in the soft tones and measured sentences of a brainy college professor, the 60-year-old executive talks about more abstract concepts such as fostering collaboration and building EQ.

Hemsley, you see, has a vision of UnitedHealth as the leading force in reforming the broken health care system. “America wants more for less, more care for less money, and we’re in the best position to make that happen,” he says. But to achieve his grand ambition, he’s tackling something that’s hard to quantify, that requires feel and emotion, and that you wouldn’t normally associate with this traditionally “results are everything” insurer: humanizing the company. “We’re in the most sensitive area of human endeavor, and we were not respectful of the importance of our role,” he says. “We’re a young company, and we were too self-centered and needlessly aggressive. I’m not proud that we needed to change, but we did.”

It’s a transformation that has until now gone largely unnoticed by the outside world. Because for a company with such an enormous footprint in the U.S. economy, UnitedHealth has managed to maintain an extraordinarily low profile. You almost certainly know the name, especially if you’re one of the 40 million Americans who carry a UnitedHealthcare insurance card in their wallet. And the company’s products and services, from Medicare Advantage plans to prescription-drug programs, touch the lives of more than twice that many people. But you’re more likely to have fought with UnitedHealth over an insurance claim than to have read much about its corporate strategy. Indeed, UnitedHealth is the biggest player in what is arguably America’s most vilified industry.

If UnitedHealth is a mystery to most, it has earned its fans on Wall Street. By financial and market metrics, the company’s long-term performance has been nothing short of remarkable. Since going public in 1984 with a mere $7 million in sales, the insurer has delivered annualized returns of 24.7% over the 28-year period to the end of 2012. That’s a total return of 48,664%. Only two publicly traded companies did better in that span, drugmaker Amgen (No. 162 in the Fortune 500) and oil refiner HollyFrontier (No. 143). UnitedHealth joined the Fortune 500 in 1995, the first year the list included service companies, and hence its first year of eligibility. That year its sales were $3.8 billion, and it ranked 303rd. This year, at No. 17, it registered sales of $110.6 billion. Its 286-spot rise is one of the most remarkable ascents in the 500’s history.

Over the past year, however, UnitedHealth’s stock price has remained flat at around $60 a share. That has nothing to do with UnitedHealth’s recent financial performance, which has continued to be brilliant: Its earnings per share have jumped 63% since 2009. Like that of most insurers, UnitedHealth’s stock has lagged because of investor fears that the Affordable Care Act (a.k.a. Obamacare) passed in 2010 will hammer profits.

Hemsley disputes this assessment. In fact, the CEO asserts that UnitedHealth’s diverse business mix means not only that the company will survive Obamacare but that it will thrive in the new environment. What distinguishes UnitedHealth is its strength in the burgeoning market for health care services, which Hemsley extols as the “industry’s emerging market.”

To understand how Hemsley has prepared his company for change, it helps to know how it is structured. UnitedHealth stands on two main legs. The first is the traditional insurance business, called UnitedHealthcare. It’s the largest carrier in the U.S. for large corporate clients, serving more than 150 of the Fortune 500. Its fastest growth now flows from government programs, like Medicare and Medicaid. For example, UnitedHealth is the largest provider of Medicare Advantage plans, in which seniors enroll in HMOs run by private insurers and receive reduced deductibles and co-pays and steep discounts on drugs.

The second pillar of the business is services, offerings collected under the Optum brand. Optum is the nation’s biggest collector of medical-claims data. Its computers hold an incredible 6 quadrillion bytes of claims records on 100 million people, exceeding the combined storage capacity of all of America’s universities. Optum sells its data services to care providers so that they can identify who’s at risk of getting seriously ill with heart disease or diabetes and which patients failed to pick up their prescriptions. UnitedHealth’s nurses and clinicians pay 500,000 house calls a year to patients on dialysis or suffering from chronic heart disease.

The challenge for UnitedHealth under Obamacare is that the new legislation places a heavy burden on its heretofore extremely profitable traditional insurance business. The Affordable Care Act, most of which takes effect in 2014, imposes a heavy tax on policies for individuals and small employers that will cost UnitedHealth an estimated $1 billion a year. Starting in 2014, the policies for those two groups will be sold through newly created “exchanges,” and their rules effectively limit profit margins for the insurers.

Of course, health care reform will also swell the number of Americans with coverage, and all those additional people will be served by private companies, led by UnitedHealth. The ACA is expected to extend coverage under Medicaid to 17 million poor and low-income Americans and will provide subsidies for 25 million currently uninsured individuals to purchase policies through the exchanges. The problem is that the growth, and the existing business, may be far less profitable than in the past.

Not so with services, which will remain far less regulated and are central to the campaigns of the government and employers to curb rampant cost inflation. Optum generated $29.4 billion in revenues last year, and sales are increasing at a 35% annual clip. Hemsley expects the unit’s revenues to hit $40 billion by 2015. The CEO is convinced that he has all the pieces in place to achieve the elusive goal of lowering costs while increasing quality, through providing pay-for-performance bonuses to doctors and hospitals for achieving both. Similar efforts have failed in the past. With newfound humility and massive resources, can UnitedHealth be the company to lead a successful health care revolution?

UnitedHealth’s history is a near-biblical tale of wealth creation, hubris, and scandal, and an exercise in redemption by Hemsley in order to, as he puts it, “find who we want to be.” The company was founded in 1977 by an entrepreneur named Richard Burke — who still serves as UnitedHealth’s chairman — as a service provider that managed HMOs and licensed them software. The historic expansion started after Burke retired in 1988, at age 44. In 1991 the board handed the reins to William McGuire, a pulmonologist-turned-empire-builder. Under McGuire, UnitedHealth made two bet-the-company deals in the mid-1990s that proved spectacularly successful.

By 1994, UnitedHealth was a regional owner and manager of HMOs. That year the prices of pharmacy benefit management companies soared, and McGuire recognized a bubble. He sold UnitedHealth’s PBM to drugmaker SmithKline, amassing a nearly $2 billion profit. Flush with cash, McGuire spied an opportunity to garner a national footprint overnight. Sandy Weill, then CEO of Travelers, had just combined its health carrier and MetLife’s health business into a joint venture called MetraHealth. The magnetic, 6-foot-6, 260-pound McGuire convinced Weill that continuing to integrate the two franchises would be a nightmare, and that health insurance was a highly specialized business he’d be better off exiting. Weill agreed. UnitedHealth bought MetraHealth and added 10 million customers from coast to coast. In 1996 it made the second transformative deal: AARP was seeking a partner to run its money-losing Medicare Supplement business. UnitedHealth wasn’t invited to bid, but McGuire sent in an offer anyway — and won. It’s now part of UnitedHealth’s Medicare business that last year generated $40 billion in revenues.

In mid-2006, the backdating scandal struck. Incredibly, the UnitedHealth board had given McGuire the authority to choose the grant dates of his stock option grants. The CEO picked either the day of the option period’s lowest price, or close to it, on 16 different grants. The board ultimately forced out McGuire, the general counsel, and the head of HR, and McGuire gave up more than $600 million in in-the-money options. Hemsley, who was COO at the time, received grants at the same prices as McGuire and was compelled to give up options, but an independent investigation found that he had no involvement in the actual backdating.

McGuire had recruited Hemsley from Arthur Andersen, where he had been CFO, in 1997. At UnitedHealth, Hemsley imposed strict minimum-return requirements for allocating what he calls “scarce, precious” capital. At the time he was more respected for his financial acumen than his people skills. “In one of the first meetings Steve held with his managers, he said, ‘If I pass you in the hall and don’t speak to you, it’s not that I’m being rude. I’m just thinking about the business,’ ” recalls Dr. Archelle Georgiou, UnitedHealth’s former chief medical officer. Hemsley is renowned for demonstrating his encyclopedic knowledge of the company’s results at quarterly financial meetings. “You can’t sandbag him,” says Georgiou. “He knows every number.”

After replacing McGuire in late 2006, Hemsley began to recognize that UnitedHealth needed to change the way it treated both customers and employees. With clients, the insurer took a “we’re the best and we know best” attitude. It tried, for example, to impose standardized policies on big corporate customers even if they wanted more tailored, individualized products, and, as a result, lost business from big clients such as Home Depot. In 2008, UnitedHealth began offering custom plans to its customers.

Inside UnitedHealth, the atmosphere had grown toxic, dominated by bitter infighting. As COO, Hemsley had divided the company into six businesses that operated quasi-independently, each with its own P&L. While the businesses served different customers, they also bought services from one another. The care management and data divisions, for example, provided expertise to the Medicare and insurance areas, and they bought claims processing from other businesses. The arrangement fueled fierce competition, but it also caused unbearable tension. “We were not sister companies,” says Georgiou. “I dreaded the meetings where we fought over how much one business would pay another for services. It was a civil war.” Hemsley makes no effort to downplay the damage wrought by the belligerent culture. “It was a challenging enterprise to work for or work with,” he says. “We had lots of IQ but not nearly enough EQ.”

To encourage collaborative behavior, Hemsley sent more than 8,000 of his managers to three-day sensitivity-training programs. They were given helpful guidelines for comportment, such as: If you get a seemingly nasty e-mail or an angry retort from a colleague, “assume positive intent.” On managers’ desks, including Hemsley’s, sit signs facing toward them with the words BE HERE NOW. That means always being totally engaged, never texting or checking e-mail during a conversation.

A major bonding experience is the annual “broomball” tournament, inaugurated in 2010 and played at headquarters in the frigid months of February and March. Broomball is a Minnesota folk sport played using a stick with a plastic blade (the broom) and what resembles a miniature soccerball — sort of like hockey in sneakers. The six-member teams play on three rinks on the frozen lake at UnitedHealth’s headquarters. The tournament is now a prized tradition, with 90 teams representing tax accounting, public relations, and every other area of the company. The games and Hemsley’s other cultural innovations appear to be working: Turnover has dropped from 20% of the workforce in 2008 to 8% last year.

Hemsley’s plan to transform health care delivery can be summed up in one word: data. By collecting, analyzing, and sharing it, he believes that he can both improve the quality of care and lower costs. The CEO is implementing his strategy through two initiatives. The first is a high-tech variation on a wellness program. Optum provides doctors and hospitals with electronic patient records to identify people at risk of getting seriously ill so that providers can coach them on improving their lifestyles. It also uses that data to coordinate care for those who already have chronic illnesses. That’s where the big savings are. The second key concept is sophisticated pay for performance, using patient data to reward doctors not just for holding down costs but also for making sure people don’t get sick to begin with. Neither wellness programs nor pay for performance is new. What’s different is the enormous growth in the quantity and quality of data and the willingness of companies and the government to embrace those techniques to tame their costs.

One of UnitedHealth’s most successful wellness programs originated with its own employees. In fact, it arose out of yet another initiative for a friendlier culture. Starting in 2010, the company offered free medical screenings and offered employees a reduction of $450 a year in their health care premiums if they volunteered for all the tests. A prime target was diabetes, for a fundamental reason. “That one disease accounts for 40% of all health care claims for our customers,” says Dr. Richard Migliori, UnitedHealth’s chief medical officer. An analysis of UnitedHealth’s claims data, he says, shows that 9% of Americans have diabetes and another 25% are prediabetic, and hence run a high risk of contracting the disease.

Diabetes often leads to down-the-road problems such as heart disease, kidney failure, and blindness. Most diabetes is fully preventable. Around 90% of the people who have it are Type 2 diabetic, meaning they contracted the illness through their lifestyle, chiefly because of obesity. UnitedHealth’s data show that people with prediabetes, identified by their high levels of blood sugar, cost $8,000 a year to treat on average, twice the figure for people without diabetes. For those with full diabetes, the medical expenses mount to $14,000.

Under its plan, UnitedHealth screened 66,000 employees. It found that 7,000 of those employees had full diabetes, and many didn’t know it. It also identified 13,000 with prediabetes. The company assigned nurses to encourage them to exercise and improve their diets. UnitedHealth’s cost for treating diabetes fell 20%. Migliori credits the program with holding its own spending on health care flat for the past two years. “We used the company as our test kitchen,” he says. Last year UnitedHealth decided to roll out its diabetes program to corporate customers. General Electric is now running a pilot program in several businesses to gauge whether it will adopt it for the entire company.

UnitedHealth’s pay-for-performance approach is rapidly gaining favor with large employers. It’s a far more sophisticated system than the old HMO approach, which paid doctors a bonus for holding down costs but didn’t provide the data to help them treat the sickest and highest-risk patients and seldom rewarded quality. Pay-for-performance plans now account for $25 billion of UnitedHealth’s revenues, and Hemsley wants to grow that total to $50 billion within five years. These plans are collaborations between the provider networks established by the insurance arm, and the data and care management services furnished by Optum. The result is that UnitedHealth and many of its competitors are moving from serving as administrators of health plans for a fee to actively managing the health of large populations, and sharing savings with providers if they can do it at a lower cost.

Here’s how the plans typically operate. A medical group signs a three- to five-year contract with UnitedHealth. That contract stipulates that most of the payments will come from two sources. The first is a monthly fee per patient, usually around $40 or $50. The second is a total based on managing costs. Optum runs projections on how much groups of, say, 50,000 patients should cost in the next year, based on age, special medical problems, and geography. The key condition is that to share in savings, the doctors must first meet stringent quality standards. They must screen a high percentage of prediabetic patients, for example, and call in people who are due for mammographies and colonoscopies.

Here is where the data revolution is critical. In the past, the physicians didn’t even know who their sickest patients were if those people didn’t come in for visits. With the constant stream of data from Optum, doctors have the tools and the incentive to find those people and make sure they come in for tests and treatments. If the practice succeeds in treating its population for less than the projected cost, the doctors pocket between 40% and 70% of the savings. The rest goes to UnitedHealth.

Despite UnitedHealth’s early success, the pay-for-performance plan is hardly guaranteed to succeed. It still isn’t clear that companies can be persuaded to continue paying for expensive preventive tests that don’t address immediate health issues. Critics of UnitedHealth also question whether such a financially driven institution has the human touch to keep people well. But, of course, it’s precisely the image of a greedy colossus driven by numbers that Hemsley is trying to dispel. “The journey never ends in trying to find the right balance between the analytical and the emotional,” he says toward the end of our interview. That applies in leading a health care revolution, as well as parenting.

This story is from the May 20, 2013 issue of Fortune.